By Peter Martin

October 19, 2011 — 3.00am

Wayne Swan may yet go down in history as the father of a monumental change to the tax system. Not merely the far-sighted, poorly-sold and now emaciated mining tax applying to just four of the originally planned 12 or so commodities, but a truly massive change with the potential to set up Australia for decades to come.

Extraordinarily generous to ordinary businesses and much more demanding of those earning super profits, the change would need the sort of patient consensus-building Swan failed to deliver in the lead-up to the mining tax.

Unions would need to be gently brought across the line. As they demonstrated by their unfortunate behaviour at the tax summit, they cannot be relied on to accept even good evidence that concessions directed at businesses could help their own members. Economist Harry Clarke wrote afterwards he ''couldn't work out if they were intrinsically stupid or just outlining a preconceived union viewpoint in bad faith; certainly they were not engaging with those who showed their views were wrong''.

Perhaps the most important finding of last year's Henry review was that in a small open economy like Australia's, high company tax hurts workers, low company tax helps.

''There is simply no debate in the academic community, there is a strong consensus,'' Henry told the summit. ''Indeed, in an academic conference that proposition would be considered so obvious that it would excite no interest at all.''

Advertisement

The sequence is that the more the company tax rate is cut, the more a country like Australia pulls in foreign capital, the more firms invest in processes that make their workers more productive, the more valuable those workers become, the more they get paid.

Swan understands the argument. He had already began pushing down the company tax rate, and would have pushed it down further had his mining tax not been kneecapped. He is attracted to a variant of the idea known as Allowance for Corporate Equity (ACE) - so much so that he gave it a special mention in his closing address.

Then he went further, asking his new business tax working group to sketch the outlines of such a system.

It was far from a throw-away idea. As well as asking the working group for a quick report on tax losses by March, he asked for a more expansive report on long-term measures, ''particularly an allowance for corporate equity'', by the end of next year.

In an inspired move he added to membership of the committee the ACTU secretary, Jeff Lawrence. Lawrence was chief among unionists at the summit spouting nonsense about the incidence of company tax.

As part of a small eight-person group he will be forced to act less like a politician and more like a collaborator assessing evidence.

At the moment companies that raise money by issuing equity are penalised compared to those that borrow. Interest payments are a tax deduction; dividend payments are not. An Allowance for Corporate Equity would level things, allowing the companies to write off against tax ''normal'' dividend payments.

And this is where it gets really interesting. They need not make the dividend payments. ''Normal'' would be calculated by applying a reasonable rate of return to the firm's total equity (even if it was a partnership rather than a public company). The reasonable level might be the average corporate bond rate.

As a result, firms that made normal returns would pay no corporate tax. Most manufacturers struggling under the weight of the two-speed economy would go from paying 30 per cent (soon 29 per cent) to nothing.

It would be partly paid for by imposing a much higher tax on the portion of earnings that exceeded the corporate bond rate. At the summit Melbourne University economist John Freebairn mentioned a rate ''more towards 40 or 50 per cent''. He will sit on the working group with Lawrence.

Highly-profitable mining companies will not like the idea. Neither will Australia's big four banks. At 15 per cent plus, they can say their return on equity is ''middle of the pack'' only because it sits between miners and everyone else.

If markets were working perfectly, no firms would consistently make such profits. Freebairn told the summit it happened where resource rents were given away cheaply, where new products cashed in on demand before the arrival of competitors and where there was a ''monopolistic-type rent''.

''And lets rub it into the banks,'' he said. ''They seem to make much higher returns than anyone else.''

If Australia got an Allowance for Corporate Equity, miners would continue to mine and bankers would continue to provide banking services. Almost every other business would get a new lease of life. If the change was presented as a simple adjustment of business taxes that also lowered the overall business tax take, it might just get traction.